Submission to National Disaster Insurance Review Terry Lustig, Environmental Management Pty. Ltd., [email protected] I am an environmental and water engineer with a doctorate in ecological economics. I have been in professional life for 47 years, working mainly in the Asia-Pacific Region, in government, private and academic roles. My consultancy has specialised in, among other matters, advising on strategies for optimally reducing the social and economic losses on floodplains. I have undertaken or participated in the economic evaluations of losses from flooding in 16 floodplains in Australia, where each property in the floodplain was surveyed individually. In addition, my consultancy has assessed the economic benefits of flood-mitigation strategies in basin-wide studies for Sydney, Newcastle, Wollongong, Christchurch and Hanoi. Since 1988, I have been advising insurance companies on the causes of inundation of properties. In all, I have undertaken or supervised the investigation of 1,000 or so such properties. More recently, I have been undertaking research into mediaeval water systems in South East Asia to see if their histories can provide lessons today. A curriculum vitae is attached at the end of this submission. This submission will explain how the flood risk is much larger than the insurance industry seems to appreciate; that it is already paying for most of the losses; and that having Automatic Cover with Opt out may have a financial result that would be little different financially from an Automatic Flood Cover model, but with a larger social cost. It will discuss how communal resilience to the flood risk tends to decline, and how it would be in the interests of the insurance industry for it to become more pro-active in reducing the economic and social losses from floods. 1 The economics of flood insurance Even where insurance companies have stated that they do not cover flood damages, I have observed over the years that they can end up paying for a significant proportion of the household losses. In 1989, we estimated from our company‟s own experience that insurance companies paid as much as half the losses to households, three-quarters of the losses to industry and 90% of floods from urban drains (Lustig and Haeusler, 1989: 14). Since then, the policies of some major insurers have been amended to include most urban flooding, and some rural riverine flooding (Irish, 2002: 114), and with one insurer all household flooding (Owide, 2002: 114), so that these proportions would be higher. It might also be noted that flood insurance is available for large commerce and industry, often at low or even zero premiums. It is difficult to understand how amending policies to include all flood losses might not be financially feasible. It is instructive to compare what happens with Australia‟s household insurance with the situation in New Zealand, where flood cover is available to households [Issues Paper A4.1] and flooding conditions are not all that different. Bewick and Lustig (1989: 143) found that the flood losses per household in New Zealand were two to three times those in NSW. Part of the reason for this was that the NZ policies covered replacement of lost possessions rather than the indemnity value. Whatever the cause, full cover was clearly affordable by the New Zealand community. It is arguable that flood insurance is also socially necessary. When one compares the social effects of flooding after the Sydney floods of 1986 and 1988 (Lustig and Haeusler, 1989: 7) with those in Invercargill, New Zealand (Luketina, 1986), the economic importance of flood insurance becomes clear. Sydney people suffered emotional stress, infections, arthritis, heart trouble, marriage breakups, alienation, disturbed behaviour and even premature death. Invercargill residents mostly experienced only stress from disruption to their normal lives. The social impacts are economically substantial. Our surveys following the 1988 Sydney floods 1 showed that the householders usually regarded the social effects as worse than the financial losses they incurred. This implies that the economic cost of the social effects exceeded the economic costs of the financial losses. In addition, there are substantial monetary costs arising from the effects on health and the cohesion of the family. In other words, the economic cost of flood losses to households is significantly more than double the direct monetary cost of losses to property, and it is reasonable to posit a factor of three. The implication that it may be easy to recover from uninsured losses to contents [Issues Paper 5.5 and 13.7] for other than low income tenants [Issues Paper 5.6] is not readily supported by the known facts. If flood insurance were universally available, this would substantially reduce the economic costs of the social affects. Thus, while non-financial social costs are monetarily uninsurable [Issues Paper 2.15, last sentence], the substantial reduction in social losses when there is flood cover means, in effect, that the most important social losses are insurable indirectly. The Issues Paper has raised the problem of moral hazard, that flood insurance will remove many incentives for mitigating the losses [Issues Paper 3.13 and 11.3]. It is felt that this is no more an issue than with any other event covered by a home insurance policy. As it is, we found in our social surveys that householders normally respond emotionally to the entry of floodwaters as with an unlawful entry, an event that is covered by household policies. Moreover, a proportion of the potential losses would be of household items that have sentimental value, so even if there were discounted premiums, there would remain incentives to mitigate losses. A far greater problem is that the resident may simply fail to take such steps through denial of the hazard [Issues Paper 15.3]. Over several decades of dealing with the hydraulic aspects of insurance claims for water inundation, I have observed that both insureds and insurers understand the distinction between flood and storm poorly. In at least one case, the insurer‟s definitions have had different meanings to what was intended, and it may be that this insurer did not conform to Sections 35(2) and 37 of the Insurance Contracts Act by derogating from flood cover in a manner that was clear to the client. [It might also be noted that this insurer persisted with some flawed definitions after it was advised of these difficulties.] While the definition of riverine flooding proposed in the Clearing the Waters report (Treasury, 2011: 5) might be thought to provide clarity, this would not eliminate the confusion as much as is hoped. According to that report (op. cit.: 3), it is proposed to distinguish between riverine flooding (Category B) and stormwater runoff (Category A), which is defined as localised flooding produced by short-duration storms. However, no explanation is provided for the meanings of „localised‟ or „short duration‟. Indeed, where similar concepts have been defined in the past, it has at times entailed hydrological and even meteorological analysis to know if a particular event was ‟flood‟ or „storm‟. Further, where both riverine flooding and stormwater runoff could impinge on a particular location, it might not be possible to determine how to classify a particular instance of inundation without professional help. This has been a major cause of delays in assessment [Issues Paper Chapter 16]. Even if maps of different types of flood risk were prepared as proposed (Treasury, 2011: 19, para. 86), it would either be “precise” and thus complex and not readily understood by lay people [Issues Paper 15.20 to 15.23]; or it would be simplistic and thus potentially misleading. Hydrology is an inexact Art, and the inaccuracies in hydrological assessments are inherently large, so that the reliability of flood maps showing the different categories of risk could be based on flawed foundations. It is thus not apparent how flood maps could help an insurer explain its derogation from flood cover clearly. I have frequently encountered situations where, even though I would normally have classified an inundation as caused by „flood‟ rather than by „storm‟, I could not rule out the small chance that it 2 was otherwise, and so had to give the client the benefit of the doubt. Such situations have not been rare events. Most flood-prone residences are in areas of low to moderate flood risk [Issues Paper 2.3 and 2.10], and these are where flash flooding or stormwater runoff are liable to be the proximate cause of the losses. This is because storm runoff arrives quickly at a property, while with these higher properties, floods take time to rise to the level that causes inundation. Thus flood mapping to show insurability by its very nature could run counter to the requirement of the Insurance Contracts Act 1984 (ICA) for the insurer to show utmost good faith [Issues Paper 15.26]. A further complication is the proposed classification of flooding from short-duration meteorological events as storm. Most urban catchments are small, and their floods would normally result from short-duration events, however defined. Thus properties upstream would be covered under storm, while properties downstream subject to the same flood may not. Since it is difficult to underpin such an outcome with logic, the policy may fail the requirements in Secs 35(2) and 37 of the ICA to explain a derogation from flood cover clearly. What is more, one can rarely know how intense the rainfall was at the site after the event, since the nearest pluviometer (an instrument for recording rainfall intensity) will normally be kilometres away, where the pattern of rainfall will have been different. So it is entirely possible—albeit unlikely—that there was a period of very intense local precipitation—much larger than what was recorded at the pluviometer—resulting in so much runoff that it was able to enter the client‟s house.